Regulator warns water firm over credit rating

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Northumbrian Water suffered a serious blow yesterday when the water regulator threatened to enforce changes to the company's licence because of concerns over its debt levels.

Ofwat said the changes would protect consumers from "any undue risks " which might emerge as a result of the Aim-listed company's debt pile. This stands at £1.7bn across the group including £1.2bn attributed directly to the regulated water business.

The warning follows a decision in May by Standard & Poor's to downgrade its rating on Northumbrian's debt from A minus to BBB, just above "junk" status. "We consider that a credit rating of BBB for the industry as a whole is unlikely to be sustainable in the long-term because of the companies' continuing capital requirements," Ofwat said.

Water companies have built up huge debts trying to upgrade outdated infrastructure and the industry has been criticised by consumer groups for threatening price rises to help fund the process.

Northumbrian said it has taken steps to improve its credit rating and Ofwat said it would revisit the need for further regulatory action in June 2004.

Possible action against Northumbrian if its rating falls below investment grade is a so-called "cash lock-up licence modification". This enables the regulator to restrict the cash flows available to the wider group which could be used for other purposes, such as the payments of dividends.

An extreme remedy would be the removal of Northumbrian's licence to operate a water company.

Northumbrian Water supplies water and sewerage services to more than a million customers in the north-east of England and water services to a further 730,000 customers in Essex and Suffolk.

The company was once part of Suez of France but a group of City investors underwrote a buy-out of the company earlier this year in advance of a stock market flotation on Aim. This valued the business at £565m. The company is in the process of moving to the main stock market. Northumbrian shares fell 3.75p to 109.5 on the news. "This development highlights our concerns over Northumbrian Water Group's 'financial inflexibility'," Dresdner Kleinwort Wasserstein said in a research note.

Northumbrian Water said it was confident of improving its credit rating by the 2004 deadline. "We have anticipated the proposed licence changes which bring the company into line with other changes in the sector."

Northumbrian's options include raising debt against revenues generated by one of its key reservoirs or obtaining from the European Investment Bank a waiver to its right to redeem its current loans, which amount to £376m.

The water industry is currently undergoing a review of its regulatory regime with a new five-year plan due to come into force in 2005.